Motor Finance: investigation if widespread misconduct

In January 2024 the FCA announced it will investigate whether there is historical evidence of widespread misconduct in relation to sales of motor finance.

The investigation is in response to the high number of consumer complaints, and that some customer complaints have been upheld by the Financial Ombudsman Service (FOS) and the Courts. (FCA to undertake work in the motor finance market).

Historical misconduct cases

The UK financial services sector has paid significant compensation for misconduct when selling financial products; amounts that can be material to a firm’s financial statements.
The most famous scandal relates to sales of Payment Protection Insurance (PPI). At least 45 million policies (maybe considerably more) were sold from the 1970s, the majority between 1990 and 2010; and the industry paid compensation of around £40bn between 2011 and 2019. (23 firms represented around 95% of complaints based on FCA data: Monthly PPI refunds and compensation | FCA). More detail can be found on the FCA and Financial Ombudsman website (some links are included at the end of the article).

Sadly, PPI is not unique. Some other recent and significant misconduct cases include:

Sales of interest rate hedging products to SMEs resulted in redress of at least £2.2bn as at Sept 2016 (Interest rate hedging products (IRHP) | FCA). Similar to PPI, sales of the products commenced many years (2001) before it was found that that there were failings in the way the product was sold (2012).
Unsuitable defined benefit pension transfer advice following the introduction of pension freedoms in 2015. The FCA indicates nearly 235,000 members took advice between April 2015 and September 2018 on transfer values worth over £80billion. When conducting reviews of the advice given, the FCA found around 50% of advice to be unsuitable: eg, the advice was not in the consumer’s best interests, there were high charges and contingent (on transfer) fee arrangements (ie, a potential conflict of interest). The FCA took enforcement action against a number of firms and introduced new rules and guidance for firms to clarify expectations for suitable advice. PS20/6 Pension transfer advice: feedback on CP19/25 and our final rules and guidance | FCA
LIBOR fixing by many leading financial institutions resulted in billion $/£ fines across the industry. The FSA’s fine (£59.5million) for Barclays in 2012 was the largest ever imposed at the time. From potentially the mid-2000s, traders manipulated the LIBOR (and Euribor) rate to generate profits on the products they sold or traded. As the global financial crisis hit in 2007, LIBOR submission rates were also understated to present a healthier view of a bank’s financial soundness. As LIBOR was a reference rate for many products, manipulation would disadvantage others (eg, if LIBOR was artificially high and used to price a mortgage, the borrower would pay more than they should).
RBS’s Global Restructuring Group was found to have failed to treat its business customers fairly or reasonably between 2008 and 2013. A particular criticism is that it prioritised asset sales for distressed business leading to the closure of the business, when those businesses might otherwise have been viable over the longer term, had an alternate approach been taken by the bank – ie, it did not ‘restructure’ as suggested by the group’s name. RBS set up a voluntary redress compensation scheme in response to the findings, as the activities were unregulated at the time.
This report from New City Agenda (2016) highlights some of these cases and more: The top 10 retail banking scandals: 70 billion reasons why shareholders must play a greater role in changing bank culture.

Motor finance is not the only current product in the spotlight. The FCA recently asked firms to suspend sales of GAP insurance and make changes to the product, due to concerns that it was not providing fair value to consumers.

There is also the potential for misconduct to beget misconduct. It is a feature of the market and one where there is the potential for significant redress for many consumers, that Claims Management Companies emerge to push claims and take a large proportion of any compensation. This can be a lucrative business which incentivises aggressive sales tactics and disproportionate charges.

Some features and issues of material misconduct cases

Misconduct issues can arise in a number of ways

Misconduct can arise at all stages of a product lifecycle and may arise in multiple ways for the same product.

The design of the product may not be appropriate. This might be due to excessive charges (ie, high interest rates, fees, or premiums), exclusions that prevent usage (eg, that prevent a claim under an insurance policy). A concern with some insurance products is that there are inherent (albeit unintended) biases – the post code lottery for example – which can lead to certain consumers (often minorities or more vulnerable customers) being prejudiced.
Within the sales and distribution channels, consumers might be induced to purchase products they do not need, or are not appropriate to their circumstance, or are too expensive.

There may be poor customer service whereby products and services are not explained or are poorly explained.
There may be conflicts of interests which incentivise aggressive selling tactics, or non-disclosure of material facts, or customers are misled (ie, lied to) into purchasing products. Discretionary commissions as with motor finance is one example of a conflict of interest; large commissions is another example.

Firms’ complaints procedures may also treat consumers unfairly. For example, complaints may be arbitrarily rejected, insufficient resources might mean there is insufficient investigation, or complicated procedures might be designed to delay or deter the complainant. In 2014, the FCA reported an uphold rate of around 70% for PPI claims (ie, in favour of the complainant), although rates were higher in some years (FOS reported an uphold rate of 89% in 2009).

PPI was not necessarily a bad product but was sold badly: as noted on the FOS website there was a range of misconduct issues.

It can affect all product and firm types

As illustrated above there have been a range of products and services affected by misconduct. This is not perhaps surprising, given the breadth of products and services available across the banking, insurance and savings markets, the potential complexity of financial products, the volume of sales, and the quantities of money involved.

There are different resolution mechanisms

If a consumer feels they have been mis-sold a product, they should in the first instance raise a complaint with the relevant firm. If the firm upholds the complaint the consumer should be provided with redress. A firm’s complaints procedures should properly and fairly assess the complaint in accordance with FCA requirements (DISP part of the Handbook): the risk however is that they are insufficiently independent of the firm or there is an unconscious bias that favours the firm.

In the event the consumer is not satisfied with the firm’s finding it can escalate the complaint to the FOS and / or they can seek to take legal action through the courts. The FOS does not, however, have the authority to hear all complaints, as set out on its website: Complaints we can help with (FOS).

Both the FOS and the courts can overturn a firm’s findings and rule in favour of the consumer. Where such a ruling is made, the FOS or courts have the power to put things right (eg, awarding compensation; or directing the firm to put things right without compensation).

It takes time for issues to emerge and be resolved

A feature of misconduct issues, and PPI in particular, is that the claims of misconduct can arise years after the misconduct event, and that establishing whether misconduct actually took place and the appropriate level of redress can also take time:

There may be a lack of awareness by consumers to make a claim or firms’ procedures may initially discourage claims. Publicity as a result of successful court cases or claims management companies can be triggers for more consumers becoming aware of the ability to make a claim and coming forward to then do so. in 2007 there were around 100,000 PPI claims; they grew steadily each year to 2010; following a court case in January 2011 they leaped to around 1.5 million and over 5.5 million in 2011 and 2012; before starting to fall away with around 4 million and 1.5 million in 2013 and 2014.
Claims may traverse both the firms’ and the FOS or the courts’ complaints processes before there is resolution. Court cases can be prolonged with appeals. It may then take time for the aggregate complaints data to identify whether a systemic misconduct issue has occurred. The FOS publishes quarterly and annual data and insights into the complaints it receives.
Establishing whether misconduct has occurred might be both a subjective and complex decision, which will also contribute to the time taken to establish whether there has been misconduct. The standards against which to measure misconduct have evolved over time. With older cases, there are fewer rules and less clarity around acceptable standards, and so the assessment can be more subjective and time consuming – though that might also mean the hurdle for proving misconduct is higher. Where the standards have changed during the period over which a product was sold, there may be further complexity to determine the relevant standards.
Firms may contest the findings against them or the actions of the FCA, as they did with PPI, which will add to the time to resolve the issues (and may lead to additional legal costs). In relation to the current motor finance claims, on 3 April 2024, Barclays launched a judicial review of the FOS’s decision to uphold a complaint about deferred commission arrangements.
The regulatory processes may be slow to identify a systemic misconduct issue and put in place processes to deal with the issue.
PPI was sold for best part of twenty years from early 90s, but only hit public consciousness in the mid-2000s, while significant provisions and payments came later. The FCA has published a PPI timeline which illustrates some of the events preceding the compensation payments by the banks – including various reviews and data collection exercises by the FSA between 2005 and 2008 that built up a picture of the market’s poor practice.

The final costs can be significant

Firms have made significant compensation payments as noted above. While individual compensation payments are typically very small (relative to large UK banks’ capital), in aggregate the redress can become significant when there has been significant sales volumes. The likelihood of greater sales increases when sales are over an extended period of time (PPI sales were mainly over around twenty years). Perceptions of good product profitability can also lead to aggressive sales tactics driving up sales volumes (and which also increase the risk of misconduct).

In addition to compensation, the costs to the industry also include regulatory fines and, perhaps more significant, the administrative and legal costs of investigating the claims and implementing remedial actions (the FOS charges £750 per case after first three: Case fees (financial-ombudsman.org.uk) and lawyers do not come cheap).

The estimation of costs is complex and there may be initial significant under-estimation

The initial estimates of compensation for PPI significantly underestimated the final cost, and the banks increased their provisions over a number of years.

As already noted there can be considerable complexity and subjectivity in assessing misconduct. Potential provisions may therefore be subject to high estimation uncertainty – for example:

What constitutes misconduct might be subjective as there may not be clear regulatory guidance or precedent, and standards may have changed as rules have changed.
It might not be clear which products are affected and over what period as this may be dependent upon the nature of, or root cause(s) of misconduct. For example, a failed distribution platform may affect multiple products, even if there is only hard evidence (eg, specific FOS rulings) for certain products. Also, the older the sales, the poorer the data is likely to be.
The basis for calculating the level of redress and other costs may be complicated or involve significant management judgement. Redress and other costs may be based on some combination of FCA expectations / rules which may evolve as the FCA becomes more involved in finding a market wide solution (eg, see FCA actions for PPI in the period 2015 to 2017), the outcomes of individual complaints, and any significant assumptions a firm may need to make (eg, projecting the number of claims that will be received, which ones will be actual misconduct, likely compensation payments, the costs of actions to manage the process).

PPI was unprecedented which may have contributed to under-estimates of how much it would eventually cost the industry. There may also have been behavioural factors, such as concerns about the impact of large losses on bank profitability and capital.

History may not be a good predictor as the FCA has responded and firms may respond differently (new issues may, however, have been created)

Over the last twenty years, the FSA, and now the FCA, have developed and evolved conduct regulation, often in response to the various misconduct cases. As a result, conduct regulation has become more stringent, both in terms of the underlying policy and the FCA’s enforcement of the policy.

The FCA’s Consumer Duty is the latest iteration of the UK’s conduct regulation and came into force on 31 July 2023. In summary, the Consumer Duty requires that:

Firms must act in good faith towards retail customers.
Firms must avoid foreseeable harm.
Firms must enable and support customers to pursue their financial objectives.
Products and services must deliver fair price and value.

The FCA’s enhanced requirements and more proactive stance might mean that the risk of misconduct is reduced, whether that be the actual act of misconduct or the period over which it is allowed to happen. Moreover, the history of PPI and the length of time for justice to be served highlights the need for the FCA to act quickly when there is a possibility of significant and widespread misconduct.

This is also necessary to bring certainty to the market in the event there is not systemic misconduct.

That said, the growth in rules, and the new Consumer Duty in particular, may add to the subjectivity and complexity of requirements that firms must meet, potentially and perversely increasing the future risk that firms fail to treat customers fairly.

The conduct of firms in response to future misconduct claims may also change, because for example, the potential high costs to investigate claims may incentivise early settlement or the need to deal with significant volumes of claims. With PPI for example, following a High Court ruling in 2011, the larger banks made ‘goodwill’ payments to PPI complainants to deal with the large volume of claims that gave rise.

What are the next misconduct issues?

It seems unlikely that the risk of systemic misconduct will disappear. The risk arises from the financial services sector developing new products and services, and delivery channels designed to generate profits at least cost. Products and services can be complex, and many individuals will not fully understand their operation or effect. Finally, the monies involved mean the potential for significant conflicts will remain, notwithstanding the FCA’s increased standards with the Consumer Duty.

Three areas to look out for where the potential risk is perhaps greatest are, the use of AI across all the stages of a product lifecycle, cryptoassets, and ‘green’ assets (see this previous ICAEW article: Greenwashing: the next mis-selling scandal?).